IBC referred Cases: Value investing or Value trap?

Investing Strategies
141

@dd1474

I see few cases where, despite huge debt that cannot be recovered from existing assets, equity was not written off to zero, and subsequently, equity shareholders were rewarded exceptionally well.

An example - Imagica that was resolved recently. In this case lenders agreed to write off 50% debt, the company issued shares to new promoters and the cash infused was utilized to pay creditors. There was massive dilution in the process (~70% dilution for existing shareholders), however, point to note that despite debt that cannot be offset by asset sale, equity was not completely wiped out and subsequently equity shareholders were rewarded exceptionally well.

ET link - equity: Banks sitting on huge gains as Imagicaa rides a turnaround - The Economic Times

This settlement was out of NCLT/IBC. It looks like creditors like to settling the bankruptcy cases outside NCLT if possible, probably because its quicker from recovery perspective.

I am trying to understand when this kind of scenario can play out? Any pointers where we can read and understand nitty gritty of bankruptcy resolution process…

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142

@amit2saxena

First, thanks for seeking my view.
The approval of this package was under RBI prudential framework for restructuring loan, which was again updated at time of COVID. The key point here is while lenders are NOT Taking write down technically (although realistically they are taking write down in present value term, for techncial purpose, there is no writedown). Total loan is divideded in two parts. Sustainable debt and Unsustainable debt. The unsustainable debt portion is sold by lenders to Aditya birla ARC which got 0.1% preference share, which were again purchased by Malpani group and converted in equity. Further, lenders themselves took around 10% stake in the company. So this is one of few restructuring which has happen under RBI framework (something similar to old CDR framework).

Hence, I can say that, at least, technically, that there is no write down in debt for lenders. Further, lenders have taken equity position and would have considered equity upside in case restructuring is sucessful and that could have also been factor for some write down. Thirdly, in order to write down equity capital, (like in NCLT scheme in IBC), lenders had to move through IBC. RBI framework does not provide equity writedown for existing shareholder. Hence, in this case lenders may have found value in equity stake on succesful being more than write down of debt and hence opted for RBI frame work. This would be exception than rule. I can understand this from lender perspective, fail to understand from new equity investor point. Why one should agree to share equity value with existing shareholder/promoter in turn around case?

Enclosing equity capital for the company, RBI Frame work, Imaggica Scheme restructuring in case any one is more interested.

RBI Resolution of Stressed Assets June 2019.PDF (431.3 KB)
RBI Resolution of Stressed Assets Covid 19 6 August 2020.PDF (226.5 KB)
Imagica Results 31 March 2023.pdf (2.5 MB)
Imagica Reoslution plan 22 June 2022.pdf (3.3 MB)

Disclosure: No investment in company, No recommendation, Not a SEBI registered advisor.

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143

I would like to continue writing on this topic while slightly digressing away from the initial objective of valuations and maybe more towards the business/process aspect, and post that creating a set of factors/observations that repeat in successful playouts.

It should be done by moving a bit backwards and understanding the whole process of CIRP/IBC along with several case studies, with the motive of explaining everyone as to how one can play this style.

I am myself discovering my way through this style as a new entrant, and unable to come in contact with people who do this in depth and can teach me, so my knowledge should be very rough around the edges ofcourse.

The previous replies in the topic got very stock specific and thus not insightful in terms of understanding this process/style, i would like to get more truer to the primary topic of IBC/CIRP, started by @dd1474. Ofcourse there would be company names, but only with the motive of synthesizing the key pointers from it that need to be followed while following this style of investing, and maybe take up the business in its own individual topic if needed rather than discussing in detail on it in this topic.

So first of all what is CIRP/IBC/Insolvency
Basically firm A took some debt from firm B to grow its operations, for any and every reason these funds couldnt be used in the best way and yielded nothing for A. As A didnt make any money off of the borrowed amount, they couldnt pay the interest costs to firm B.

Now B first tries to settle the amount through OTS (one time settlement)/any other way at a reduced amount and gives more time to A (this may not happen every time, and A can directly go under insolvency before these other measures), but A still hasnt been able to payback B.

Finally B goes to NCLT to lodge a case, A is then declared under insolvency.

While being declared as insolvent most of the firms are loss making and some even do not have any sales. So no need to get alarmed by seeing that, as these firms do now have access to funds (wc), they are unable to carry on operations.

The next thing that happens is that the NCLT in unison with B brings in a resolution professional (RP) to helm the ongoing operations (while the previous management loses control over the company) and come to a solution.

The solution the RP can come to is to either liquidate the firm or bring in a new management (resolution applicant/RA) who infuses funds to pay back B and revive the operations.

Now if there is no resolution applicant, the firm goes under liquidation, we investors dont even need to look at it as it does no benefit us in any way.

The game is to be played if a decent/capable RA comes in.

The steps

  • B lodges a case in NCLT against A

  • Appointment of RP

  • Meeting of committee of creditors (B and other entities like B)

    • Mind it, there are several meetings before they come to a decision, and this whole process is very long

  • Announcements in newspapers and other mediums by A, in order to invite bids (expression of interest- EOIs) from RAs

  • Then EOIs comes in from RAs

  • Then few more meetings of committee of creditors (coc) takes place in order to select a SRA (successful resolution applicant) and their rp (resolution plan) submitted by the SRA

  • Finally after a RA is approved from coc, it then needs approval from the NCLT

  • Post approval an implementation and monitoring committee (IMC) is formed, consisting of the RP and the RA, who take over the board and keep watch on the progress of the rp submittee by the RA.

  • Finally after some time IMC leaves and the whole control is given to the RA, and the RA starts bringing in new board members

  • While submitting the rp, there is also a clause of reduction in capital.

    • This means that majorly (90%+ usually) of the shareholding is diluted and the whole control is given to the new management.

  • Now since 90%+ shareholding is with the new mgmt, according to the sebi rules they need to bring it to 75% ans below, now to do this they either get in an investor or OFS it to the public.

Thats the basic summary of the whole process.

If anyone uses this style extensively please share the granular points and learnings.
Will share case studies soon, the idea behind sharing case studies would be to understand the space better along with achieving the ability to gauging the future outcomes more accurately.

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144

Some correction:
While previous mechanism like CDR and restructuring did provided for moratorium and debt repayment to align with Cashflow, as per IBC act, just on default (not even on being NPA, i.e. 90 days overdue payment), lender/operational creditor/employee/service provider can refer the company to NCLT. So there is no requirement theoritically for B to negotiate settlement with A. That is being change from previous regime.

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145

you are right, maybe i didnt frame it well, i was taking this example in a normal course of things, as to this is what usually happens in case of established firms unable to payback. For very small firms, yes they usually directly get referred to NCLT.

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Thanks Rahil for summarizing the process and also thanks to @dd1474 for starting this thread. Its very insightful . Is there any portal such as regulators website where we can find pending cases and status etc?

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Refer to this website to know status of case and order.
https://nclt.gov.in/
You may refer to enclosed website for IBBI related information
http://www.ibbi.gov.in/

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148

Diamond power case study, they got the rp approved on 20 jun, 2022.

  • COC received and discussed the resolution plans on 13.11.2019, wherein the COC rejected both plans and passed a resolution to liquidate the Corporate Debtor.

    • Patience is key in this style, one will get limited ideas here, where again it would take a long time for things to pan out. In the last few months following this space, i have only found 2 investable ideas here whereas i would be following close to 20-30 cases, waiting for them to pan out.
    • No point in jumping on the news of resolution plans coming in, one needs to wait for NCLT approval at the least.

  • On 26.03.2018 the C.B.I. registered an FIR, against the MD and Joint MD of the Corporate Debtor, because it was noticed that a consortium of eleven Banks were cheated to the tune of Rs. 2654.40 Crores

    • One of the biggest alpha comes out in following change, it can be seen how big of a change it could be if and when the mgmt changed, try to invert and think in all possible outcomes.

  • There was only one resolution applicant

    • although i prefer if there are multiple RAs, it shows the value of that asset and thus the desire for it
    • Although i also prefer a one time upfront payment clearing all dues (preferably without debt), the RA here had planned to pay 431cr deferred over 5yrs. Again its a debatable topic and varies from owner to owner as to how he prefers to use his funds, maybe we can perfect this as we understand multiple cases.

  • 501cr for the whole cirp process and 300cr for capex and wc were to be paid by the RA

    • Capex and wc funds are important to track as to understand how the operations will grow and be funded post-acquisition.

  • As per the approved resolution Plan there shall be no delisting of the scrip

    • this is mentioned in every NCLT approval doc and needs to be checked

  • Resolution Plan submitted by GSEC Limited in consortium with Rakesh Shah

    • Working on the acquirers one would have easily seen they do not have any background in this industry. This is a huge negative at first glance, but one needs to patiently keep following updates.
    • And then these acquirers brought in an extremely strong and experienced professional mgmt to helm the operations
      • A strong team helming the operations is a must and needs to be watched, its the top thesis pointer in this sort of a turnaround
      • Its also important to understand that most of the times the old mgmt of the debtor continues at the helm as hired help for some time to smoothen out the start/integration, and thus non technocrat promoters may not matter much.
        • the whole point here is to individually judge the capabilities of both, the acquirer and the business being acquired, and then calculate the risk to reward.
      • sometimes there is nothing wrong in the underlying business its just that they are capital starved and once they get access to capital everything goes back to normal and the firm grows, thus i would like to again put emphasis on judging the acquirer and the business individually.
        • Looking at the historical nos one could have seen what the company used to make pre 2015, and then understand where things went wrong for them. We can see what sort of asset expansion took place post 15, which was funded through debt, execution of their plan went haywire. I prefer such entities where there were huge numbers and brands before but due the errors/wrong steps/execution issues from the mgmt side crushes the entity’s health, thereby giving a huge opportunity to the informed.

  • According to the rp, share capital of the company shall stand reduced and extinguished to the extent of 99% such that shareholders holding less than 100 shares will not get any shares and their shares will be extinguished in full.

    • This needs to be watched on, and from what i have understood till now is if one is to enter the scrip, it is to be post reduction only

  • Numbers started improving from December quarter itself, attach the quarterly img

  • Hired Price Water house Cooper LLP (PwC) as Internal Auditor, one of the well known names

    • These small things indicate the intent of the mgmt and needs to take up a significant space in the overall thesis

  • Within 4 mts of acquisition, they began commercial production at the inoperative plant

    • few entities move very slow post mgmt change, minute data needs to be watched to understand mgmt aggression and overall plan, will share another case study which is currently playing out where the execution is pretty slow while the new mgmt has huge huge capabilities.

  • Orders started flowing in from april 2023, again proving the plans of the new mgmt.

To conclude, i would have added a significant part of my initial position as soon as the capital reduction was done, seeing the caliber of the professional mgmt (hired) alone, post that seeing the improvement in numbers i would have doubled the initial position, and then lastly kept on adding on the smaller updates like hiring PwC.

This is all in hindsight, but thats the whole point of it, to understand how to play these things.

The price move is a whole different thing and may have been due to several reasons and is sort of a one off, but the above points were key and them playing out solidifies ones thesis otherwise

Yes the current valuations may seem expensive but thats what ‘’change’’ does, looking for change leads to a lot of alpha, now thats a whole different thing that half of this alpha maybe due to unnecessary reasons but who are we to judge where that alpha comes from. PLAY THE ODDS AS THEY COME.

Not an investment suggestion.

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149

Thanks for the insightful details. Can you few ongoing cases tat we can track to build better understanding of IBC process?

Another note - I found this article (link below) from SEBI website, which talks about minority shareholders having 5% of the post diluted capital , based on book building issue like Rights, on the same terms and conditions at which acquiring shareholder is awarded stake in the company. This is to ensure minority shareholders interest are taken care of in IBC process.

This looks to be a draft regulation but efforts in this direction looks interesting.

https://www.sebi.gov.in/reports-and-statistics/reports/nov-2022/framework-for-protection-of-interest-of-public-equity-shareholders-in-case-of-listed-companies-undergoing-corporate-insolvency-resolution-process-cirp-under-the-insolvency-and-bankruptcy-code-ibc-_64850.html

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a few interesting ongoing cases-
golden tobacco
precision containeurs
eastern silk
eastern sugar
mt educare
starlit power

this is not an advice, i dont have any position in any of the above names, i maybe tracking them if i found their business interesting or the current progress in their IBC status worth tracking.

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151

How do you find or keep track of ongoing resolution cases?

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152

going through the announcements on the exchange regularly

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@Amit2saxena asked me a question, which i think might help everyone
the question was-
in ongoing IBC, if there is agreement between CoC and aquirer and 1) company owns valuable assets and 2) plan is to keep the company listed, then case becomes very interesting.
Example - 1) Amusement park of Imagica 2) Processing plants of Ruchi Soya
In the cases that I mentioned above, what part of the asset base i found interesting. For example, in case of Golden Tobecco or MT Educare?

my answer-
in golden tobacco its not about the assets, its about the list of prospective resolution applicants, i have never seen that many individuals being interested in any firm. In any of the IBC cases i read, i do not give any particular preference to assets, if its there then its a bonus.
I have a very simple strategy to follow change, any business going from 0 to 5 or 0 to 10 will give the same returns till a particular point (10 being the firm with strong assets and value and 5 with nothing special or significant), so i need to hold the firm till that particular point and then understand its value, in this way i broaden my target area (universe of firms), while also not getting paralysed while analysing the small units of data which prevents me from cashing out alpha till that particular point.

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154

I wish life was so simple, even I would have taken over sick company under NCLT and became promoter of listed companies. Whenever the companies undergo insolvency, there would be multiple issues, from non-payment to operational creditor, labour union related issues, EPFO defeaults (which is criminal offence in my understanding for directors during that period and company), cheque dishounour resulting in 138 ACT cases under Negotiable instruments. While the IBC is kind of going to insulate new promoters and company. But company would continue to receive notices till all stakeholder take note of fact. For instance, State Government would continue to issue notices of past VAT (despite Act provide clearnace under IBC).

There are lot of practical issues involved. While the new promoters are insulated, but still, since system are not prefect, one would continue to receive notices for past offences/issues. So need to present and mention the development. Even that involve cost of lawyers and other efforts on time/attention. So it would be very inefficient way to get listed particularly when SME migration to main board is relatively simple and there are more than 2000 companies which are solvant and name shack business. Hence, only positive part would be income tax shield on unaccounted loss against which in kind problems need to evaluated by new management while bidding in IBC. In nutshell, one would require team of professionals to take over company under IBC and it has mutiple issues which need to address. Life is beautiful but not simple, in my view.

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155

while whatever you have shared is facts, all this like you said has no significant weight on the acquirers since they clear all amounts/defaults according to their resolution plans.

There is no further demand or scrutiny which can be taken forward by existing or new creditors regarding the past once the NCLT has approved the resolution plan, there maybe certain cases of plant closures or shutdowns which may have been done in the past due to environmental issues, but i dont think so there can be anymore demand on the funds side of things once the rp is approved.

keeping it simple again, one would only invest if they see value, all these transactions would for sure be in mind before becoming a prospective resolution applicant. Regarding the listing, maybe yes, maybe no, i dont think that plays any part in this discussion, because we see acquirers coming in through cirp route constantly, so no point in going against the facts

it would be very helpful if you could shares more problems which can be faced by the acquirers, it would maybe add to my base since whatever CIRP cases i am tracking once the mgmt changes/changed, the only thing that changed were numbers (sometimes for the worst), efficiencies (increased) and business clarity.

lastly, i completely agree that life is not simple, you need to measure the odds and play it in your favour. Strictly keeping risk to reward in mind, till now IBC has been great for me, maybe thats because i have been able to keep it simple (its not easy for sure) by following change, or maybe its beginner’s luck.

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So, just coming basic point, the company has defaulted and not able to honour its obligation. In more than 95% of the cases, Financial creditors/opertional creditors need to take waiver on their claims. In simple finance, when lenders take waiver (which mean cashflow value/assets value of company is not able to meet debt obligation), equity value is nil. In that scenario, why would rationale investor offer equity value in such IBC cases to equity holders?

In my understanding, only two reasons can justify equity value.

  1. Accumulated losses can be utilised as tax shield in future by profit making new investor in case they merged IBC referrred company
  2. In case of listed company, acquisition of IBC give indirect listing route to new investor (after merger of existing business, something similar to Orchid Pharma and Bhushan steel post Tata group acquisition).

In these situation, 99% of resolution plan have following clauses:

  1. Full writedown of equity owned by previous promoter group
  2. 90-99% equity value wirte-down by previous non-promoter group shareholding
  3. Some stake being given to financial creditor for waiver of claim

Subsequently, equtiy share face value would be consolidated to previous value. So a minority shareholder holding 100 shares of Rs 10 face value each (Total face value Rs 1000), would end up on 90% write down 100 share of Re 1 each (Total Face value 100). Subsequently, share capital would have consolidated face value of Rs 10 each resulting in 10 shares of Rs 10 each (Total face value of Rs 100).

Now when the scheme is implemented, very few shareholder would have shares which are available in their demat account. Someone holding 1,00+ share only would be 10 shares now. Furtther, the new listing approval and allotment also take some time. During that period, we she major volatility in such shares. I would strongly advise investors to understand whole events timeline and cautiously look at investing during these volatile period.

Enclosing certain example of volatility during that period.
Orchid pharma: 24 July 2019 price Rs 5.45, delisted, and post corporate restucturing (IBC approval resolution plan) reslited on 6 Nov 2020 Rs 20.75. Price went up from Rs 2527 per share on 1 April 2021, almost 100x during 5 months with very limited volume of 1,000-4,000 shares traded per day. By March 2022, share price declined to Rs 282, almost 89% decline.

Same pattern can be observe from Ruchi Soya (Now Patanjali) and Alok textile.

The biggest risk while investing in these company at very low price, the reoslution plan may provide for delisting with complete write down of old equity capital. In such situation, one has write off investment one hold in such companies. Probability of such incidence would be in very high (say more than 50-60% cases). Given such outcome, I would sugest every one to careful and not carried away by just price increases. It would be very difficult even during upswing to exit from such stock in my limited undestanding.

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